The Basics of Starting a Small Business

There's more to starting a small business than selling goods or services. Here's a discussion of some of the complications you'll have to navigate.

By the MOTHER EARTH NEWS editors

| March/April 1983

Thinking of starting a small business? Unless you're using your own money, you'll need to obtain financing.Photo by Fotolia/mangostock

For many people, an important part of living the American Dream involves having the chance to take a stab at being one's own boss by picking up on an idea and turning it into a profitable reality. And now, when a lot of folks are actively seeking career changes (by choice or necessity), it may just be the ideal time to test the entrepreneurial waters by starting a small business.

Unfortunately, the statistics regarding annual new business start-ups and failures can be alarming. It seems that roughly eight of every ten new ventures fail within five years. But there's no reason why yours can't be one of the 20% that survive and prosper! To help insure that'll happen, however, it's a good idea to study some of the available literature on the subject, and to consult with as many professionals as possible.

No business activity should, for example, be undertaken without the advice of lawyers and accountants, and a smart entrepreneur will also enlist the aid of the nearest field office of the Small Business Administration (SBA), the only federal government agency specifically set up to assist the potential (or practicing) small-business person.

Get Organized

First of all, you need to establish a business plan that outlines [a] your objectives, [b] your potential market, [c] your plan for reaching that market, and [d] your method of operating the business. Before you take even the first step toward locating financial backers, you should have those items thought out and the answers presented in writing. After all, no investor can be expected to take an interest in sponsoring your venture if you haven't shown enough interest in it yourself to set down a detailed plan of action.

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However, once you've established your course — and assuming that you yourself don't have the capital necessary to implement your program — the next step is to locate financing. Your first stop should be the office of the nearest commercial banker. You see, although you might not succeed at getting a business loan from that institution, banking personnel — who generally have a wealth of contacts in the community — may be able to both advise you of and point you toward potential private investors in your area.

There's yet another advantage to be gained by seeking help at a bank: Once you've been turned down by at least one commercial lender, you see, you can contact the Small Business Administration for assistance in locating funds. In fact, the SBA itself can guarantee loans up to $500,000, at an interest rate not more than 2.75% over prime. Since the money involved is still bank money, though, it's wise to keep in mind that most lending institutions will expect you to produce $1.50 worth of collateral for every $1.00 you seek to borrow.

Commercial finance institutions, small business investment companies, and business development corporations are other possible sources of loans. Friends and family members can also be helpful sometimes, but in such a case it is necessary to be sure the loan is made in an appropriately professional manner, complete with a signed contract detailing the amount borrowed, the fixed rate of interest, and an outlined schedule of repayment.

Forming a Firm

Legally speaking, there are several ways to organize a new business. Most folks begin with a "sole proprietorship," which is the least complicated form. The owner is the business in this instance, so all of the enterprise's liabilities are assumed by the individual. Although there's no need to have a lot of contracts or other legal documents drawn up for a sole proprietorship arrangement, the assistance of a good lawyer is still recommended. He or she will see you through the process of obtaining all the necessary permits and help you outline your tax obligations.

Then again, you may find it necessary (or advantageous) to take a partner when you set up your new venture. A general partnership represents a relationship between two (or more) individuals who have joined together to carry on a trade or business for profit. Each partner is fully liable for the firm's obligations—unless the partnership agreement specifically restricts those liabilities and meets certain other legal requirements for a limited partnership — and each partner's share of the profits or losses is reported on his or her individual tax return. One primary disadvantage inherent in establishing a partnership is that when you do, you're legally responsible not only for your business actions but often for the actions of each of your partners, as well!

Corporations are the "robots" of the business world. Each is a legal entity that's separate from the principal participants involved. It's therefore liable for its own debts and taxes, and it's also given the freedom to distribute profits as it sees fit. A corporation is headed by a board of directors, whose job it is to guide policy. The actual owners of corporations are listed as stockholders, and one "partner" can sell his or her shares of stock in the company without necessarily dissolving the business. However, because incorporation is such a detailed and expensive process, most small-time entrepreneurs avoid it until such time as their businesses really "take off and roll".

Small enterprises also have the option of forming a corporation under a governmental "Subchapter S" designation. In this case, the shareholders of the corporation elect to be taxed individually for their proportionate share of profits and losses. To qualify for this classification, a company must have fewer than ten shareholders, be a totally domestic operation, offer only one class of stock, and consist of shareholders who are all United States citizens and residents.

Acquiring Insurance

Be sure to enlist the aid of a competent and experienced insurance broker when you begin to put together your new venture-for-profit. Insurance is a complicated business and is becoming more so each day. Some types will likely be required by law, while other kinds can be considered smart investments because they can protect your personal assets and those of your business.

To cover areas of physical loss, you'll need policies protecting your enterprise against fire, lightning, wind, flood, vandalism, riots, robbery or burglary, casualty, and damage resulting from use and occupancy, plus "extended coverage" protection to guard against explosions, smoke damage, or bad storms. If you lease a site rather than own a building outright, be certain that the agreement spells out which insurance obligations are yours as tenant, and which are the responsibility of the owner.

The "family" of policies that relate to personal injury claims includes public liability, worker's compensation, employer's liability, and product liability. And there are still other types of protection that could be important, depending on the nature of your business. These include life insurance, automobile insurance, and policies that cover health and accidents, business interruption, income continuance, and the bonding of employees.

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Other Legalities

Licenses, permits, and other legal matters are very real (and often annoying) aspects of small-business ownership. Again, a good attorney will be most helpful in assisting you as you slice your way through all the necessary red tape.

Most businesses require a federal identification number, a state retail sales license (if the enterprise involves selling), a city occupational license, and (perhaps) even a county merchant's license. Permits are generally issued on an annual basis, require accompanying fees, and often involve some kind of written application.

The government will issue you an employer identification number on request, which you'll be expected to use on all business returns, documents, and statements made in connection with the enterprise. However, the individual owner's social security number will still be required on income tax returns, self-employment schedules, and declarations of estimated tax.

If you operate your new venture under any name but your own, you'll need to register it with a local government agency. This regulation is known as the AKA/DBA law (meaning "also known as" or "doing business as ..."). Some areas may require you to publish the registration in the classified section of your local newspaper.

Certain kinds of businesses require special permits. For example, any restaurant or shop that sells food will have to obtain a permit from the county health department. (This also means opening yourself up to on-the-spot, unannounced inspections of your premises by county officials.) Hairdressers, auto repair shops, exterminators, real estate firms, and insurance agencies are examples of other businesses that usually require special occupational licensing from the state. Federal licensing, on the other hand, is generally required only for gun dealers, security and investment brokers, television and radio stations, and pharmaceutical firms.

Whenever you sell a product directly to the public, you have to charge sales tax. (Certain items are exempt, but these will vary from state to state.) Nowadays, many states require that you post a bond — or pay an advance deposit — against future sales tax when you apply for a permit. In exchange, you'll be issued the permit and a "resale number," which will effectively legitimize your retail operation.

Another legislative "headache" that must be dealt with concerns the myriad zoning regulations found in most communities. If you're operating a quiet business out of your home, of course, it's unlikely that you'll encounter any hassles from the zoning board. However, if your operation is clearly a retail or manufacturing enterprise, you should be well aware of the limitations imposed on you by local ordinances. (Be especially aware of these restrictions when you shop for a piece of property with the intention of establishing a business on it.)

Business Tax Tips

There are many tax advantages to owning your own business. But before you begin operating as an independent, remember that you cannot deduct expenses that you haven't kept track of. Therefore, you must make record-keeping an automatic part of your day-to-day existence. If you're operating a sole proprietorship, the tax form that applies to you is Schedule C-1040, and it's available from the Internal Revenue Service upon request.

This form will detail a number of the deductions that you can take. For example, you should be able to claim some of the expense of maintaining your car if you use your vehicle to conduct business activities.

Furthermore, you could receive a tax credit for hiring help that meets federal "minority" or "handicapped" status. And if you join professional groups or trade organizations relevant to your work, you can deduct those membership fees, as well as the travel expenses to and from the groups' conventions or conferences. Working from your home sometimes allows you to claim a certain percentage of your household costs as business expense, too.

Advertising Advice

The greatest idea in the world will fizzle out fast if people don't know about it, so a vitally important part of your business will be getting word of your goods or services to the market you hope to reach.

One of the best means of promotion — particularly if the business you're establishing is service-oriented — is a listing in your local telephone company's Yellow Pages under an appropriate heading. Find out what the charges are and when the directory goes to press, then be sure to submit your information well in advance of that date.

If you're operating a retail outlet, you'll find that a large window sign can be an easy and inexpensive way to announce the forth-coming business. Likewise, a simple handbill or flyer that can be posted on community bulletin boards (in the coin laundry or supermarket, for example) will also help make your offerings known to the general public.

In addition, nowadays most communities have a weekly "shopper" newspaper that serves as an inexpensive way to advertise services or wares (and if your area doesn't have one, starting such a publication would be a good business for you to consider). A few lines in that, and/or in the classified section of your "real" newspaper, will always be a good advertising bet.

As your business and profits grow, you may be able to expand your promotional efforts to include large display ads in newspapers and magazines, radio and television messages, or a direct mail campaign.

You're on Your Own!

If and when you do decide to break away and try to succeed as a self-employed person, you'll quickly find yourself getting the kind of education that's not to be found in books. This article is meant to serve only as a general overview. It's certainly not intended to replace the excellent advice to be had from bankers, lawyers, accountants, and others who make a business of businesses. Do keep in mind, as you plan, that it's a rare venture that creates substantial profits during its first few years. As you make financial projections, see that you have enough capital on hand to maintain you and your family until your company gets a fair crack at achieving success. Given enough planning and persistence, however, you'll more than likely find that you are able to make your American Dream come true.

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